C-Suite Wednesday — New Law Makes ESOP Financing More SBA 7(a) Friendly

August 22, 2018

C-Suite Wednesday — New Law Makes ESOP Financing More SBA 7(a) Friendly

By Dominic J Bartolone
Contributing Editor

A new bill recently signed into law just made it easier for companies with an ESOP structure to obtain SBA financing.

The Main Street Employee Ownership Act, included in the 2019 National Defense Authorization Act, signed into law last week, promotes ESOP participation by removing restrictions that prevented access to SBA financing.

The new bill makes amendments to Section 7(a) lending practices that should eliminate some obstacles and expand the SBA’s ability to aid the establishment of ESOPs through more loan guarantees for ESOPs.

Here are some of the changes we see helping ESOPs:

Ability to make back-to-back loans under SBA Section 7(a) program.

Previously, an ESOP loan guaranteed by the SBA could only be made to the ESOP trust. This restriction made it hard to qualify with an approved lender without pledging collateral that was not held in trust. They instead would be forced to make an internal loan to the trust, called a “back-to-back” loan arrangement. Changes in the Act amends the 7(a) program to allow back-to-back loans, which are more aligned with current practices.

SBA 7(a) ESOP loans can now be made under the Preferred Lender Program.

The SBA previously did not allow 7(a) ESOP loans to be made PLP, making the application process more difficult and time-consuming. The Act now allows the SBA Administrator the ability to authorize participating PLP lenders to offer SBA 7(a) ESOP loans to qualified applicants.

Sellers now allowed to remain involved in the business.

Previously, the SBA prohibited sellers who did not wish to become a 100% ESOP-owned entity right away and instead chose to progressively ease out of the business. The Act changes those restrictions by now allowing a seller to remain as an owner, officer or key employee of the business, as long as the ESOP acquires at least 51% of the company. However, if a seller remains as an owner, he or she would be required to provide a personal guaranty for an SBA-backed loan.

Allow SBA financing to pay for ESOP transaction costs.

The SBA 7(a) program prevented SBA financing from paying for the transaction costs associated with the ESOP. The Act reverses that rule and now allows ESOP costs to be rolled into an SBA loan.

SBA can waive eligibility requirements.

The SBA previously required that an owner retain ownership equal to at least 10% of the total transaction costs. The SBA now has the ability to waive this eligibility requirement.

If administered properly, the Act should improve the ability of ESOP-structured companies to obtain financing from an approved SBA lender under the 7(a) program.

The changes are also a significant win for small businesses across the nation who may be considering converting their business structure to employee-owned, as well as encouraging for SBA lenders seeking to expand their loan offerings.